First Russia, Then Turkey, Now Sanctions on Venezuela -- What About Oil?

Even if Maduro steps down or is forced out, it will take years to rebuild the country's oil industry.

Over the past year, the U.S. has placed sanctions on many countries that refused to acquiesce to the "Make America Great Again" paradigm. Are countries to be treated like belligerent two-year-olds that need to be punished by their parents (aka the U.S.) taking away their iPads? One wonders.

First Russia, then China, then Turkey, and now Venezuela. Call me naive, but shouldn't politics be about negotiation and compromise working towards a mutually beneficial solution, or is it just all about old school bullying? That is what Trump is used to, but politics is not business -- and nor should it be, as there are much larger stakes involved; civilian casualties and prospects of war.

No one can dispute Venezuela is and has been in a state of crisis for some time. Its presidents have misused the country's resources as opposed to optimizing them; classic developing country dilemma.

It is a shame that a country that once produced nearly 4 million barrels per day (mbpd) is now forecasted to producing less than 1 mbpd. Oil exports from Venezuela have been falling. According to RBC Capital Markets, they forecast another drop of 300,000-500,000 bpd in 2019. And now, the U.S. Trump administration has just slapped sanctions on its state-owned oil firm, Petroleos De Venezuela SA (PDVSA), a move aimed to force President Maduro to step down and cede power to self-proclaimed President Juan Guaido.

The purpose of the sanctions is to block $7 billion in assets and $11 billion in revenue from lost exports in the next year. The sanctions stop PDVSA from collecting oil proceeds and hence funding the current regime.

Oil is Venezuela's largest source of revenue and the U.S. is their largest customer, with 41% of their exports going to the U.S., and their biggest foreign asset is Citgo, the U.S. based refinery arm of their oil company. Venezuela exports about 500,000 bpd to the U.S. making it the third-largest oil importer to the U.S. For purpose of comparison, the U.S. imports about 3.6 mbpd from Canada, 1.05 mbpd from Saudi Arabia, and 377,000 bpd from Iraq; the fourth largest source of foreign oil that flowed into the U.S. last year.

Here is the caveat. Secretary Steven Mnuchin has authorized "certain" transactions to still be allowed from PDVSA; Citgo assets would be allowed to operate in the U.S. Under the new sanctions, U.S. companies can purchase crude from Venezuela only if the proceeds are held in a different account that cannot be accessed by the Maduro regime. Will they be willing is another matter.

The type of oil that comes from Venezuela is classified as "heavy" oil, which is able to be processed by U.S. refineries owned by Valero Energy (VLO) and Chevron (CVX) . If these refineries are not able to get the crude from Venezuela, they will have to find alternative, more expensive sources, which will hurt their profits. These Gulf Coast refiners cannot operate on U.S. shale alone, and have come to rely heavily on Venezuela for this type of oil.

Why is Venezuela so important, and can these sanctions put upward pressure on the price of oil?

In terms of potential reserves, Venezuela is quite important. According to the BP Statistical Review of World Energy 2018, it put Saudi Arabia's oil reserves at 266.2 billion barrels at end-2017, or 15.7% of global oil reserves, second only to Venezuela's 303.2 billion barrels.

OPEC and U.S. shale could easily make up the difference if need be, given the excess surplus in the markets currently. The timing of the need for extra supply could not come at a better time, as the world faces lower demand as world slows down. But this will not happen overnight, as it will find ways to sell its crude to India and China, albeit at a higher discount as their refineries are the only ones able to process that type of crude.

Even if Maduro steps down or is forced down, it will take years to rebuild the country's oil industry. Going back to the hay days of 4 mbpd of oil will certainly take years, if not a decade, depending on the situation. The country's GDP has fallen by 37% between 2012 and 2017, according to the IMF. Inflation is projected to reach a jaw-dropping 10 million percent in 2019!

Venezuela can be a lucrative region. There is room for improvement, hence the need for government change and perhaps why the focus from other foreign governments to acknowledge the newly elected President instead of Maduro.

A full embargo would certainly put a squeeze on oil prices, but that is not on the agenda as of now. One thing is certain, if U.S. and China come to some sort of a resolution on the Trade Wars, then oil will get a boost. Most commodities, especially Base Metals like Copper, Iron-ore and Steel will rally first, as those markets are the tightest, but oil will benefit as well, even if lagging its commodity brethren.

Thanks to OPEC and OPEC+ taking around 800,000-1 mbpd out of the market since December, the market is tightening somewhat, but is still some way off to reaching a deficit given the lower demand prospects. Depending on how easily Venezuela can displace U.S. barrels away from the U.S., oil will be supported around $60/bbl Brent for now, barring a full-blown U.S./China recession and talks breaking down.

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